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Asked to define “strategy,” most executives would probably come up with something like this: Strategy involves discovering and targeting attractive markets and then crafting positions that deliver sustained competitive advantage there. This view of strategy as position remains central in business school curricula around the globe.

Unfortunately, writes the author, investors don’t reward senior managers for simply occupying and defending market positions. Equity markets are full of companies with powerful positions and sluggish stock prices. Merely sustaining prior financial returns, even if they are outstanding, does not significantly increase a share price; tomorrow’s positive surprises must be worth more than yesterday’s.

Zenger argues that managers’ most vexing strategic challenge is not how to win or sustain competitive advantage but, rather, how to keep creating value. He offers what he calls the “corporate theory,” which reveals how a given company can do just that. Drawing on the history of Disney and Apple, he describes what makes a corporate theory strong, shows how it informs strategic choices, and warns what can happen when a company loses sight of its theory.

Photography: Courtesy of Pace Gallery

Artwork:Tara Donovan,
Untitled, 2008, polyester film

If asked to define strategy, most executives would probably come up with something like this: Strategy involves discovering and targeting attractive markets and then crafting positions that deliver sustained competitive advantage in them. Companies achieve these positions by configuring and arranging resources and activities to provide either unique value to customers or common value at a uniquely low cost. This view of strategy as position remains central in business school curricula around the globe: Valuable positions, protected from imitation and appropriation, provide sustained profit streams.

Unfortunately, investors don’t reward senior managers for simply occupying and defending positions. Equity markets are full of companies with powerful positions and sluggish stock prices. The retail giant Walmart is a case in point. Few people would dispute that it remains a remarkable firm. Its early focus on building a regionally dense network of stores in small towns delivered a strong positional advantage. Complementary choices regarding advertising, pricing, and information technology all continue to support its low-cost and flexibly merchandised stores.

Despite this strong position and a successful strategic rollout, Walmart’s equity price has seen little growth for most of the past 12 or 13 years. That’s because the ongoing rollout was anticipated long ago, and investors seek evidence of newly discovered value—value of compounding magnitude. Merely sustaining prior financial returns, even if they are outstanding, does not significantly increase share price; tomorrow’s positive surprises must be worth more than yesterday’s.

Not surprisingly, I consistently advise MBA students that if they’re confronted with a choice between leading a poorly run company and leading a well-run one, they should choose the former. Imagine assuming the reins of GE from Jack Welch in September 2001 with shareholders’ having enjoyed a 40-fold increase in value over the prior two decades. The expectations baked into the share price of a company like that are daunting, to say the least.

To make matters worse, attempts to grow often undermine a company’s current market position. As Michael Porter, the leading proponent of strategy as positioning, has argued, “Efforts to grow blur uniqueness, create compromises, reduce fit, and ultimately undermine competitive advantage. In fact, the growth imperative is hazardous to strategy.” Quite simply, the logic of this perspective not only provides little guidance about how to sustain value creation but also discourages growth that might in any way move a company away from its current strategic position. Though it recognizes the dilemma, it offers no real advice beyond “Dig in.”

Essentially, a leader’s most vexing strategic challenge is not how to obtain or sustain competitive advantage—which has been the field of strategy’s primary focus—but, rather, how to keep finding new, unexpected ways to create value. In the following pages I offer what I call the corporate theory, which reveals how a given company can continue to create value. It is more than a strategy, more than a map to a position—it is a guide to the selection of strategies. The better its theory, the more successful an organization will be at recognizing and composing strategic choices that fuel sustained growth in value.

The Greatest Theory Ever Told

Value creation in all realms, from product development to strategy, involves recombining a large number of existing elements. But picking the right combinations out of a vast array is like being a blind explorer on a rugged mountain range. The strategist cannot see the topography of the surrounding landscape—the true value of various combinations. All he or she can do is try to imagine what it is like.

In other words, leaders must draw from available knowledge and prior experience to develop a cognitive, theoretical model of the landscape and then make an educated guess about where to find valuable configurations of capabilities, activities, and resources. Actually composing the configurations will put the theory to the test. If it’s good, the leader will gain a refined vision of some portion of the adjacent topography—perhaps revealing other valuable configurations and extensions.

Companies that enjoy sustained success are typically founded on a coherent theory of value creation. All too often such companies get into trouble when the founders’ successors lose sight of that theory—whereas turnarounds, when they occur, often involve a return to it. The history of the Walt Disney Company provides a case in point. Its founder had a very clear theory about how his company created value, which was captured in an image held in the company’s archives and reproduced here (see the exhibit “Walt Disney’s Theory of Value Creation in Entertainment”).

Walt Disney’s Theory of Value Creation in Entertainment

This 1957 map of Walt Disney’s vision defined his company’s key assets, including a valuable and unique core, and identified patterns of complementarity among them. It implicitly revealed the industry’s future evolution and provided guidance concerning adjacent competitive terrain that Disney might explore. The asset and capability combinations that emerged from the theory have evolved with time, but the theory itself has not fundamentally changed.

The image depicts a range of entertainment-related assets—books and comic books, music, TV, a magazine, a theme park, merchandise licensing—surrounding a core of theatrical films. It illustrates a dense web of synergistic connections, primarily between the core and other assets. Thus, as precisely labeled, comic strips promote films; films “feed material to” comic strips. The theme park, Disneyland, plugs movies, and movies plug the park. TV publicizes products of the music division, and the film division feeds “tunes and talent” to the music division. Walt’s theory in words might read: “Disney sustains value-creating growth by developing an unrivaled capability in family-friendly animated (and live-action) films and then assembling other entertainment assets that both support and draw value from the characters and images in those films.”

The power of this theory was perhaps most vividly revealed following Walt’s death. Within 15 years leadership at Disney seemed to lose sight of his vision. As the company’s films markedly shifted away from the core capability of animation, the engine of value creation ground to a halt. Film revenues declined. Gate receipts at Disneyland flattened. Character licensing slipped. The Wonderful World of Disney, the TV show that American families had gathered to watch every Sunday evening, in a nationwide embrace, was dropped from network broadcast. By the time I entered college, in the late 1970s, the Disney franchise many of us had grown to love as children had all but disappeared.

Attesting to the depths of Disney’s disarray, corporate raiders in 1984 attempted the unthinkable: a hostile acquisition of the company with a view to selling off key assets, including the film library and prime real estate surrounding the theme parks. The capital markets embraced this idea, leaving the board with a critical choice: sell Disney to the raiders, who would pay a significant price premium but dismantle the company, or find new management. The board chose the latter and hired Michael Eisner.

Eisner rediscovered Walt’s original theory and used it to guide a heavy investment in animated productions, generating a string of hits that included The Little Mermaid,Beauty and the Beast, and The Lion King. Over the next 10 years Disney’s box office share jumped from 4% to 19%. Character licensing grew by a factor of eight. Attendance and margins at the theme parks rose dramatically. Disney’s share of income from video rental and sales soared from 5.5% to 21%. Eisner opened new theme parks, made further investments in live-action films, and expanded into adjacent businesses consistent with the theory, including retail stores, cruise ships, Saturday morning cartoons, and Broadway shows. By essentially dusting off Walt’s theory and aggressively pursuing strategic actions consistent with it, Disney won growth in its market capitalization from $1.9 billion in 1984 to $28 billion in 1994.

That cycle has repeated itself in the years since: Although the move into Broadway shows was complementary to animated films, character licensing, and theme parks, other strategic moves, such as the 1988 acquisition of a Los Angeles TV station, the 1995 purchase of Cap Cities/ABC, and the 1996 purchase of the Anaheim Angels, failed to reflect the theory’s logic. Meanwhile, Eisner allowed the core animation asset to atrophy again as the company failed to keep up with technology trends and the best-in-the-world animators migrated from Disney to Pixar. Disney gained access to their skills through a contract, but the relationship between Disney and Pixar grew contentious and was finally severed just before Eisner stepped down, in October 2005.

His successor, Robert Iger, quickly moved not merely to repair the Pixar relationship but to acquire the company, for more than $7 billion. Disney’s recent acquisitions of Marvel and Lucasfilm fuel this central asset, although they carry the company into somewhat unfamiliar terrain: The Marvel and Star Wars casts are quite different from Disney’s traditionally princess-heavy character set. Whether this strategic experiment proves to be value-creating remains to be seen. But Walt Disney’s road map for growth has clearly endured long past his death, providing a remarkable illustration of posthumous leadership.

The Three “Sights” of Strategy

The Disney strategy has all the hallmarks of a powerful corporate theory. It has consistently given senior managers enhanced vision—a tool they repeatedly used to select, acquire, and organize complementary bundles of assets, activities, and resources. How can you tell if your own corporate theory is as good? The answer depends on the extent to which it provides what I call the strategic “sights”: foresight, insight, and cross-sight. Let’s look at these a bit more closely.

Foresight.

An effective corporate theory articulates beliefs and expectations regarding an industry’s evolution, predicts future customer tastes or consumer demand, foresees the development of relevant technologies, and perhaps even forecasts the competitive actions of rivals. Foresight suggests which asset acquisitions, investments, or strategic actions will prove valuable in predicted future states of the world. It should be both relatively specific and somewhat different from received wisdom. If it is too generic, it won’t identify which assets are valuable. If it is too widely shared, the desired assets and capabilities will be expensive to acquire (because competed for) or else not unique (and therefore unlikely to create sustained value). Walt Disney’s foresight was that family-friendly visual fantasy worlds had vast appeal.

Insight.

If competing companies own assets identical to yours, they can replicate your strategic actions with equal or perhaps even refined capacity, thus undermining any superior foresight in your theory. An effective corporate theory is therefore company-specific, reflecting a deep understanding of the organization’s existing assets and activities. It identifies those that are rare, distinctive, and valuable. Disney’s key insight was recognizing the value of the company’s early lead and substantial investment in animation and its capacity to create timeless, unique characters that, unlike real actors, required no agents.

Cross-sight.

A well-crafted corporate theory identifies complementarity that the company is singularly able to assemble or pursue by acquiring assets that can be combined with existing ones to create value. Disney’s theory suggested a broad array of entertainment assets that could draw value from a core of animation.

Together these three sights enable leaders to compose a succession of value-creating actions. Foresight regarding future demand, technology, and consumer tastes highlights domains in which to search for cross-sight. Insight regarding unique assets focuses the search for foresight and cross-sight. Cross-sight reveals valuable complementarities, highlighting the domain of foresight.

Steve Jobs’s Corporate Theory of Value Creation

On August 10, 2011, Apple surpassed ExxonMobil to become the world’s most valuable corporation—a remarkable feat for a company left for dead in 1997. Although credit for Apple’s success correctly goes to Steve Jobs, the real substance of his genius has often been misunderstood. Like Walt Disney’s, his greatest contribution was not a product, a plan, or a managerial attribute; it was a corporate theory of value creation—one that nearly every purported industry or strategy expert consistently encouraged him and his successors at Apple to abandon.

Jobs’s theory was apparent in the famous Apple II computer, launched in 1977. Although its inner workings were the brainchild of Apple’s cofounder, Steve Wozniak, Jobs was responsible for the friendly packaging, the sleek casing, and the marketing-focused company that brought the product to consumers with tremendous fanfare. A wave of entries into the personal computing space followed, each introducing a unique software and hardware platform.

But in 1981 the industry was transformed when IBM introduced the IBM PC. It was an instant success, widely applauded for its open architecture. The industry rapidly moved toward generating IBM-compatible software and hardware. Cheaper, faster, and greater storage capacity quickly came to define competitive success. Competing platforms rapidly disappeared and 15 years of intense competition ensued, until Dell eventually discovered a powerful position.

Jobs, however, continued managing to a very different set of performance criteria, reflecting his theory of value creation. That theory not only guided Apple’s strategy in computing but defined a succession of future moves and choices. It took on greater clarity with time, but essentially it held that consumers would pay a premium for ease of use, reliability, and elegance in computing and other digital devices, and that the best means for delivering these was relatively closed systems, significant vertical integration, and tight control over design.

Like Disney’s, Jobs’s theory incorporated all three strategic “sights.” It was inspired by foresight about the evolution of customer tastes. Jobs recognized that computers would become a consumer good, akin to the Sony Walkman. He believed that consumers would appreciate aesthetics and aspired to create a device with the elegance of a Porsche or a well-designed kitchen appliance.

His insight was that the internal capability most critical to value creation in this competitive terrain was design. Of course, that was in part a reflection of his personality: Jobs was a self-proclaimed artist, obsessed with color, finish, and shape; but he transferred this obsession to the technology as well. Walter Isaacson, Jobs’s biographer, wrote, “He got hives, or worse, when contemplating great Apple software running on another company’s crappy hardware, and he likewise was allergic to the thought of unapproved apps or content polluting the perfection of an Apple device.” In pursuing Jobs’s focus on design, Apple made heavy R&D investments, much larger in percentage terms than those of any of its competitors.

His theory also provided cross-sight, in that it helped Jobs identify external assets through which value could be created, including the graphical user interface (GUI) technology that Apple obtained from Xerox. During his famous visit to Xerox, Jobs repeatedly expressed incredulity that the company was not aggressively commercializing the technology. He saw that GUI perfectly fit his theory, because it made a computer easy to use and attractive to engage with. Some regard what next transpired as one of the greatest technology transfers in history.

The Macintosh was the first fully formed embodiment of Jobs’s theory, and it garnered wide acclaim and remarkably high margins (as Jobs had predicted). But the IBM standard was already well established, and the opposing network economics were overwhelming. Although the Mac survived as a very profitable niche product, Bill Gates and others exerted enormous pressure to port the look and feel of the Macintosh operating system to the IBM platform. Jobs, however, refused to countenance any such experiment.

For years academics and journalists derided this strategic refusal. Jobs was banished from Apple for more than a decade, in part for his dogged insistence on sticking to his theory. His subsequent vindication has become the stuff of legend. He returned to Apple in 1996, shortly after the struggling enterprise had been shopped unsuccessfully to HP, Sun, and even IBM. Most people anticipated that he would simply dress the company up for sale. Instead he reimposed his theory with a vengeance, trimming the product range and introducing a new line of Macintosh products, not available for license. More important, he used it to explore adjacent terrain, producing a remarkably successful series of strategic moves across a wide range of product categories.

Apple was not the first to design a digital music library, manufacture an MP3 player, or market a smartphone. But it was the first to craft and configure those devices and their user environment with elegant, easy-to-use designs and with tight control of complementary products, infrastructure, and market image. Apple has shown that Jobs’s theory has broad application beyond computing, with industries and product categories ranging from TV, video systems, home entertainment, portable readers, information delivery, and even automotive systems as possible targets. In contrast, the well-positioned Dell has struggled to find a way out of a declining PC industry.

When Strategy Lacks a Theory

Not all corporate theories are created equal, however, and some companies never discover valuable ones. The story of AT&T is a case in point.

In 1984 the seven regional Bell Operating Companies were spun off from AT&T, eliminating Ma Bell from local telephone service and slashing assets from $150 billion to $34 billion. AT&T was left with its long-distance business, its manufacturing arm (Western Electric), and its R&D organization, Bell Labs. With no clear path for growth, the company needed a new theory of value creation.

Its first strategic actions after the breakup suggest that its leaders had composed a theory whereby they would leverage what they perceived as broad managerial competence to invest large cash flows from long-distance service in diverse acquisitions and new businesses. Over the next several years the company got into data networking, financial services, computing, and an internet portal. The market was distinctly unimpressed, and in 1995 AT&T abandoned its diversification theory, announcing that it would divest two key assets, NCR and Lucent Technologies—essentially carving itself into three distinct companies.

Management quickly composed a new theory that reflected its belief in the value of acquiring the “last mile” connection to local customers and providing a bundled package of telephone, broadband internet, and cable services. This theory drove a series of costly cable-industry acquisitions in 1998–1999, totaling more than $80 billion. Unfortunately, the theory was rather widely shared by other companies and investors, and purchase prices reflected this (the cost per subscriber exceeded $4,000). Nevertheless, the market initially applauded these moves, driving AT&T’s share price to an all-time high of $60. But by May 2000 the stock had dropped back close to $40 a share. In response, AT&T again began questioning its theory—or at least its ability to sell that theory to Wall Street. In October 2000 the company announced that it would spin off the wireless and cable units, and five years later it put itself up for sale.

The moral of the AT&T story is clear: It pays to invest a lot of time and energy in crafting a robust theory that, like Disney’s, is quite specific as to how combinations of assets create value. AT&T’s first theory following the breakup never made clear how the company’s supposed managerial competence could be uniquely applied to new types of assets; it lacked insight and cross-sight and certainly any vision of the future. The company’s second theory was equally flawed: It contained foresight, but in a form that was already widely shared and thus could not generate unique cross-sights.

Bargain Hunting with a Corporate Theory

The real power of a well-crafted corporate theory becomes particularly evident when companies go shopping. Value creation in markets always comes down to prices paid, and a good corporate theory enables the acquirer to spot bargains that are uniquely available to it.

An effective corporate theory is company-specific; it identifies those assets and activities that are rare, distinctive, and valuable.

Mittal Steel is a good example. From its origin, in 1976, until 1989, it was a very small player in an industry consistently ranked at the bottom in financial performance. Mittal began as a small mill in Indonesia, where it developed a capability in a new iron ore input technology called direct reduced iron (DRI), which provided mini-mills with a high-quality alternative to scrap metal.

Mittal simply grew with Indonesia’s emergence as a tiger economy. But in 1989 it made its first major expansion move by acquiring a troubled steel operation owned by the government of Trinidad and Tobago—a mill that was operating at 25% capacity and losing $1 million a week. Mittal quickly proceeded to turn this business around as it transferred knowledge, deployed DRI, and increased sales. A succession of significant acquisitions followed over the next 15 years, primarily of assets in the former Soviet bloc; each proved to be a gold mine.

A clear and simple corporate theory guided this acquisition program: Mittal knew how to create value from poorly understood and poorly managed state-owned steel operations in developing economies where demand for the product was growing fast. To other steel companies, many of which were focused on improving their internal operations, acquiring such assets—especially ones with integrated technology and large iron ore deposits—was unthinkable, so the field was wide open for Mittal.

Mittal’s insight was its understanding of the value of DRI and its own ability to lead turnarounds in formerly state-owned enterprises. Its foresight was an early recognition of the value of iron ore assets—given the strong growth in demand for steel in emerging economies—and the virtues of industry consolidation. Its cross-sight was to recognize the types of assets that could benefit from the company’s distinct capabilities.

By 2004 Mittal had emerged as the world’s largest and lowest-cost steel producer. Lakshmi Niwas Mittal, the company’s owner, is now one of the world’s wealthiest people. This success came from having a corporate theory that functioned as a rather remarkable treasure map, one that continues to reveal assets uniquely valuable to Mittal.The psychologist Kurt Lewin famously commented, “There is nothing so practical as a good theory.” Theories define expectations about causal relationships. They enable counterfactual reasoning: If my theory accurately describes my world, then when I choose this, the following will occur. They are dynamic and can be updated on the basis of contrary evidence or feedback. Just as academic theories enable scientists to generate breakthrough knowledge, corporate theories are the genesis of value-creating strategic actions. They provide the vision necessary to step into uncharted terrain, guiding the selection of what are necessarily uncertain strategic experiments. A better theory yields better choices. Only when your company is armed with a well-crafted corporate theory will its search for value be more than a random walk.

Todd Zenger is the Robert and Barbara Frick Professor of Business Strategy at Washington University in St. Louis.

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